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TFS Financial Corp (NASDAQ:TFSL)

Q3 2011 Earnings Call

August 04, 2011 10:00 am ET

Executives

John Ringenbach - Chief Operating Officer of Third Federal Savings & Loan Association

Paul Huml - Chief Operating Officer and Chief Accounting Officer

David Huffman - Chief Financial Officer and Member of Investment Committee

Meredith Weil -

Marc Stefanski - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Jessica Ribner - FBR Capital Markets & Co.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

Jessica Ribner

Mike Shafir - Sterne Agee & Leach Inc.

Unknown Analyst -

Operator

Welcome to TFS Financial Corporation's Third Fiscal Quarter Earnings Conference Call and Webcast. Hosting the call today from TFS Financial is Mr. Marc Stefanski, Chief Executive Officer. He is joined by Mr. Dave Huffman, Chief Financial Officer; Mr. John Ringenbach, Chief Operating Officer of Third Federal Savings; Ms. Meredith Weil, Chief Retail Officer of Third Federal Savings; and Mr. Paul Huml, Chief Accounting Officer. Today's call is being recorded and will be available for replay beginning at 1:30 p.m. Eastern Standard Time. The dial-in number for the replay is (800) 677-6124.

[Operator Instructions] Some of the information provided during the conference call may contain statements of future expectations and other forward-looking statements. These expectations are based on the management's current views and assumptions and involve known and unknown risks and uncertainties. It is possible that the company's actual results and financial condition may differ, possibly materially from the anticipated results and financial condition indicated in these forward-looking statements.

For a discussion of some of the risks and important factors that could affect the firm's future results, see Risk Factors in the company's latest annual report on www.thirdfederal.com. TFS Financial Corporation assumes no obligation to update any forward-looking statements provided during the conference call.

It is now my pleasure to turn the floor over to Mr. Marc Stefanski. Sir, you may begin.

Marc Stefanski

Good morning, everyone, and thank you, Beth. I would like to immediately turn the floor over to Paul Huml, who will go over the highlights that we've compiled in the deck that some or most of you or all of you may have received. And then we'll open it up for questions and comments. So Paul, if you want to jump in and begin the presentation?

Paul Huml

Okay. Thanks, Marc. Just want to get started. The slides that are out there, you can move through the slides and view whatever ones you want. I'm going to try to go through and just sort of hit some of the highlights, not intending to go over everything on every slide. So then we'll have time for questions at the end.

Going in to Slide 3, just a little background information on Third Federal and TFS Financial. We completed our IPO in April of 2007. We trade on NASDAQ. Total assets at June 30, around $11 billion. Shareholders' equity is about a little over 16%, and we are a mutual holding company. So while there's 308 million shares outstanding, the Mutual Holding Company owns 227 million of those. So there's a little over 81 million that's actually traded on the public markets.

Just a little -- on Page 4, just a little background on our operation. Started in Ohio, but we also have 17 branches in Florida that were all started de novo, that we've started from scratch. Branch sizes, average about $223 million per branch.

So going over to Page 5, just a strategic overview, our business model is basically first mortgages for residential customers. I mean, that's what we've done. We continue to stress the conservative underwriting as part of our approach to -- with the equity lines of credit to GAAP we have reduced by the regulators. We have gone into a adjustable rate, a smart rate program that we started in July 2010. So we -- 2010, so we continue to push that. We've also started to look at doing some refinancings with that product in other states, kind of a new product that we're pushing out.

Just to stress, all of our loans are originated by noncommissioned Third Federal associates using the same conservative underwriting standards for all of our branches. We continue to strive to be a low-cost provider. We think that's a big advantage to us. And we have shown in the past that we understand the financial aspects of shareholders through buying back shares and paying dividends.

Going onto pages 6, just hitting some of the key financial highlights. We've put up some information for prior years and previous quarters, but the provision for loan losses that stayed consistent the last couple of quarters, our ratios, capital ratios are remaining very strong. Our net interest margin improved during the quarter from where it was last quarter. So we're -- things are starting to trend up. There's definite signs that things are on the upside.

So there's a number of stats down there. You're welcome to review on that on your own and if you have questions later on.

Again, on the next page, loans and deposits. We're a fairly simple story with residential mortgage loans and consumer deposits. We don't do consumer loans. We don't do business checking. We're a very simple operation, and it's part of the low-cost provider. We try to keep high average deposits in our branches. You've seen over $223 million per branch.

And stressing, on Page 8, where we are from a capital spend standpoint. I think no matter how you look at it, whether it's at the thrift standpoint or from the public company holding company TFS Financial, our equity positions are very strong and have remained strong.

Obviously, in today's economy, on Page 9, delinquencies and charge-offs have been a key item to look at. I think one of the things that we looked at is our issues have focused in some of the real estate in Florida and the HELOCs in Florida, which have caused some high delinquencies and also some of the first mortgages there. But if you look at Ohio and Kentucky, it's thrown in there just because we have Cincinnati loan origination offsets. But the Ohio piece, which represents the bulk of what we're doing, has maintained fairly low delinquencies when compared to where things are in the industry. So we feel pretty good about that. I think we're working to get our arms around the situation in Florida and working on that.

Obviously, the Home Today has high delinquencies. They've always had high delinquencies. There's not a lot of new loans going in to the Home Today portfolio. It's mostly in runoff stage at this point.

We see high delinquencies but really, the charge-offs are not that severe because we've done a lot from restructuring with those customers. We have a lot of private mortgage insurance as well that helps keep our losses on those loans down. We see a lot of in and out of delinquencies in that portfolio. And as I say, it's a small piece of the overall portfolio and has been going down for the last 2 years.

Page 10, just wanted to go over some of the adjustable rate loans that we've been originating in response to the lack of the equity lines and credit that we've been doing. And as you see, over the last few quarters, we've been able to get our production down to around a 50-50 mix of adjustable rate versus fixed rate. We have traditionally, over the years, been a mainly fixed-rate lender, which adds to the interest rate risk. So in today's market, we've looked at doing more adjustable rates, which helps lessen that interest rate risk.

All the origination and underwriting that we've done have remained very consistent, very conservative. You can see the average credit score of the ARM production, and the LTV is very good, 62%. The average score, 775. So through that production, which really started in July of 2010, we've been able to increase our adjustable mortgage to up to 23% of our total first mortgages. So we're very happy with that growth.

And as I mentioned, we are looking at some additional states that we've started taking applications in, Pennsylvania, New Jersey, Illinois and North Carolina. Still kind of early in the game on that, but we hope that to be an area of growth as well.

And then on 11, sort of an issue that we've had, and I think a lot of people who followed, there's been a Memorandum of Understanding that we originally got from the OTS back in August of last year, which was amended and revised and replaced in February of this year, and some of the things that they ask for. I'm just trying to give you an update on where things are.

In the February MOU, they asked for us to go out and do an interest-rate, an enterprise risk management study. Both of those studies are complete. We're in the process of implementing a new interest rate risk modeling system. We've established risk management committees at both the board level and at management level. And we feel very comfortable at where we are with the overall enterprise risk management approach.

Some of the other things that the OTS had asked for was management compensation studies and succession plans. All of those studies have been complete and submitted to the regulators. We have various operational policies, mainly revolving around the equity line to credit, ongoing account maintenance and those type of issues. And those continue as we move forward. And probably, the biggest piece was the financial piece of the Home Equity Reduction Plan, and that we had a December 31 deadline on that for those goals. Those have been met as of June 30. And as you can see on the next page, on 12, where we stand with those goals. The goal was to get our commitments down by $1 billion by the end of December of 2011. We've actually exceeded that at June 30.

The home equity balance reduction, we have a goal of $300 million by the end of December. We have exceeded that as of June. And some of it, just to recap, the $150 million capital infusion from the holding company down to the thrift that was completed in October. That really had no bearing on overall capital of the company. That was just a internal allocation of capital down to the thrift. And as I mentioned, the expanded line management on account management collection processes that continue, particularly in regards to our home equity line of credit.

Another chart on the next page was really just to show what the goal was that we had committed to the OTS, was 261% to get our home equity portfolio as a percentage of our capital and allowance. And that was to achieve that by the end of December. And again, you can see we exceeded that as of June 30.

So those -- obviously, all these requests in the MOU is with the OTS. Obviously, in July 21, we now have 2 regulators, which is the OCC and the Federal Reserve. So we have to make sure that those 2 parties are comfortable with the information that we've provided and what we're doing from an operational standpoint.

On the next slide, you'll see obviously, from an investor standpoint, dividends and stock repurchase is a big part of what we do. We try to have a 3-part approach to how we use our capital, and this is 2 of them. Dividends and stock repurchases, and the other is growth of the company. But dividends and stock repurchases have been curtailed as we're working through the issues in the MOU. As we've alerted people before, we have to provide 45 days notice if we want to do that for their approval. We need -- with the new regulators coming in as of July 21, we understand that dividends and stock repurchases can be a key component, and I think that's something we're looking to get back to. We have to make sure that we can get our new regulators comfortable with what we're doing to get us back on that path. And what the exact timing of that is unknown at this point. We're certainly working with them to get there as quick as possible.

And really, just in summary, I mean, our focus is high-quality, 1-to-4 mortgages, primarily in our banking footprint, but we are looking in some other states for some growth. We have a strong capital position, and we have a lot of flexibility at the holding company. And we're certainly working with the new regulators to resolve the MOU and get our efforts on returning to some of the shareholder-enhancing activities of dividends and share buybacks.

So just sort of a summary where we are at the quarter, I know a number of people have certainly questions out there with the new regulators coming in and what the impact is going to be. I think we -- that'll continue to be a work in process as we start to meet with them and go over what their reviews are.

So at this point, I'm going to turn it back over to Beth, and she'll instruct people how to work the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Daniel Arnold with Sandler O'Neill.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

So I guess my first question is just, I guess, on the MOU here. And I wanted to see if you guys have had -- started conversations with your new regulators and what they kind of -- if they have indicated what the process would be from here in getting this lessened, if there are any additional steps that they indicated they wanted you to take? Or if it's now just a matter of them reviewing the existing MOU that's in place and seeing if that makes sense?

Marc Stefanski

We have a meeting scheduled with the Fed, actually, next week. But we have not engaged in any formal discussion with either one of the regulators on our position as far as the MOU or the buybacks or the dividends. So that's up-and-coming. We've talked casually with them, and we've had discussions, of course, since we first started this process way back in February. But as you know, in a regulatory environment, the official baton wasn't handed off until July 21, and that's when their actual process begins in terms of the analysis of our company or any other company that's involved in the transition.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

And I mean, those conversations next week, is that part of a formal exam? Or is that just kind of an introductory meeting?

Marc Stefanski

No, I think that it's not part of a formal exam. I think that the Fed, along with the OCC, is still trying to determine the order in which they're going to organize the processes moving forward, along with the people. And so next week, we'll be meeting with the folks that will be our new regulatory line of command from the Fed's perspective. And -- but yes, I mean, that's when the more formal talks will begin about where we stand and if we stand at all in terms of anything that's done, that's been said and done with the policymakers in D.C.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

Great. And then just as it relates to once this MOU gets listed and you guys are able to buy back stock and pay dividends, how do you guys balance those 2? And what -- with the stock trading where it's at right now, what do you think is the more effective use of capital right now? And how aggressive are you going to be on both ends?

Marc Stefanski

Well, actually, our growth strategy, as Paul mentioned, is a 3-tiered approach. It's growing the balance sheet, along with buying back stock and paying dividends. So we, hopefully, will be doing all those things in the very near future.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

Okay, but you don't have a preference for one of those right now? Or that, I guess, will depend on where things are at?

Marc Stefanski

Yes, it really does depend where things are at. And we're prepared. If we're not able to pay dividends, which we don't know at this point, then we're prepared to continue the buyback program, if that's allowed as we move forward.

Daniel Arnold - Sandler O'Neill + Partners, L.P.

Okay. And then, I guess, last question. Just as you guys look at your capital level, obviously the complexion of the balance sheet right now is a lot different than it was even a few quarters ago, just given the home equity exposure and the addition of first-lien mortgages. Does that affect what you guys think is kind of a normal operating capital level in that the risk on the balance sheet is actually lower? Do think you can operate a kind of lower normalized capital level than you could before? Or how do you feel about that? And what is kind of a normalized capital level in your guys' minds?

David Huffman

This is Dave Huffman. I think it's always relative to where we are in different cycles. You mentioned that it's less risky than we were a few quarters ago, but if we went back a year ago, we had almost $1 billion in cash. So from that standpoint, we have to be sensitive to where we are in different cycles. We hope we're coming out of the delinquency troughs and that we'll see a continued improvement on that score. And to the extent that improves, that might imply that we need a little bit less capital. As you'll recall, when we had the IPO, we probably raised more than we expected when we started the process. And our capital levels were very high. And we started the program to reduce those, and as both Marc and Paul have indicated, it's a 3-pronged attack. And I think that we would intend to leverage the balance sheet a little bit more. But when we look back 2 years ago at the level of capital that we have, that's been kind of a saving grace for us because the capital level is so strong that it really takes out of the equation, in our mind anyway, the risk of a more severe environment that we can weather through things as we've done. And it's almost circumstantial. So we'll just have to see where we are at the point in time and see what the risk profiles look like.

Operator

Our next question comes from Paul Miller with FBR Capital Markets.

Jessica Ribner - FBR Capital Markets & Co.

This is Jessica Ribner for Paul. Just one question. You're looking to expand your 1-to-4-family mortgage business out of footprint as well?

Marc Stefanski

Yes, that's correct.

Jessica Ribner

And so what's your strategy for that? And where would that be?

Marc Stefanski

Meredith?

Meredith Weil

This is Meredith Weil. We are currently expanded into Pennsylvania, New Jersey, Illinois and North Carolina. We're using a very similar strategy to our equity strategy when we expanded our equity business out of state. We've been doing direct mail and using Internet advertising to drive business through our customer service center and our Internet channels.

Jessica Ribner

Okay. Just one more question if you don't mind. Are you guys seeing a lot of competition within footprint and even on the -- at your marketing strategy out of footprint? Have you seen increased pricing competition or anything like that?

Meredith Weil

I think the competition is consistent with how it's been in the past. I think that the broker market has definitely changed a little bit. But because rates are so low, I think, that really, there is definitely rate competition out there. I think we've seen some success in our new space. It is too early to really tell. We really expanded at the end of May, so our results are still preliminary. But we've been able to really get out there and have interest, even though we don't have a big brand presence in those new states.

Operator

Our next question comes from Mike Shafir with Sterne Agee.

Mike Shafir - Sterne Agee & Leach Inc.

I was just wondering real quick on a housekeeping question. What's a good tax rate to use moving forward?

David Huffman

This is Dave Huffman. If you can tell me what our earnings are, I can give you a great tax rate. We do have the -- our biggest permanent difference item is our bank-owned life insurance, the BOLI program, and we have a little over $165 million in that. And the income from that creates the biggest tax difference. So if that income is in the $5 million or $6 million range, I would just adjust your estimated pre-tax earnings by that. Does that help you?

Mike Shafir - Sterne Agee & Leach Inc.

Yes, that sounds good. And then just as we think about kind of the balance sheet and what's gone on so far on the credit side, non-accruals have come in the last couple of quarters, and your charge-offs have remained relatively flat. And it seems like things are starting to stabilize a little bit. So the bulk of those charge-offs have come in that home equity portfolio, and with the big reduction that you guys have had, could we potentially start to see charge-offs a little bit lower over the next couple of quarters?

John Ringenbach

This is John Ringenbach. I can try to help with that. I think the biggest concern we have, and there has been some positive trends both in delinquencies and in the charge-offs, but the biggest concern we have continues to be the employment situation. That's where most of our challenges are. Our special servicing group goes up, which does the modification for mortgages, is still very busy. Our collection team is still working diligently with customers, and the thing they see the most is folks who are underemployed or lose their employment. It's just a challenge. And I think if we see some improve in the economy, some improvement in employment, we'd feel better about things. But right now, it's not immediately obvious if that's happening.

Paul Huml

One thing I want to add on that on the charge-offs is really, from a specific reserve standpoint, that's part of our allowance, which could impact the level of charge-offs. Under the OTS, they have a specific reserve that can be included in your allowance. The OCC does not have that total view. So I think there is a potential that some of those specific reserves turn into charge-offs as we head into a new regulatory world. So that won't really impact what we're doing from a P&L standpoint and provision, but it can impact the level of charge-offs.

Mike Shafir - Sterne Agee & Leach Inc.

Okay. And then I was just wondering, do you guys have the TDR balance on renegotiated loans for this quarter?

Paul Huml

I think the TDRs have been -- the increase has been pretty consistent to what it was prior quarter. Probably went up about $9 million for the quarter.

Operator

[Operator Instructions] And our next question comes from Joe Stephens [ph] with Stephens Capital.

Unknown Analyst -

All my questions have been answered except for one. What's the cash position at the holding company right now?

Paul Huml

We generally have about $250 million of capital that sits at the holding company. That's invested in a couple of different pieces. It's probably -- the cash piece is probably in a $150 million range.

Unknown Analyst -

Okay. So it hasn't really changed too much? Okay.

Paul Huml

No.

Operator

And our next question comes from Ross Haberman [ph] with Haberman Management.

Unknown Analyst -

I was just wondering, could you elaborate, on one of your slides, you talked about the operational issues, which you're working on, which you're not, I guess it said you're not quite done. I was wondering if you could elaborate, if possible, on what that is and what you still have to complete.

John Ringenbach

There's a number of examples in that...

Unknown Analyst -

I think it was Slide 11.

John Ringenbach

Yes, got it. There's a number of examples of that, but one example would be account management techniques in terms of our equity line of credit portfolio. And we are working with some third-party vendors and also internally to improve our account management techniques, trying to predict better who might be having a problem in the future and how we might be able to work with those customers. And that does require a lot of modeling. And that modeling is probably going to take another 3 or 4 months to complete. So that would be an example of where we're trying to revise our internal operating procedures but are not quite finished yet.

Unknown Analyst -

Is that the major item left? Or there's a bunch of smaller items as well as that?

John Ringenbach

I think there's some smaller items left in terms of some of our collection processes and how we do those and using different techniques and phone systems. So I'd say that's the largest one, but there are some other smaller ones, too.

Unknown Analyst -

And do you think you'll be able to accomplish all that by when?

John Ringenbach

I think we'd like to see the major pieces completed by the end of the year.

Unknown Analyst -

The end of the calendar year?

John Ringenbach

Correct.

Operator

[Operator Instructions] It appears there are no further questions at this time. I'd like to turn it back to Mr. Marc Stefanski for any closing remarks.

Marc Stefanski

Well, I just wanted to thank all of you for chiming in. And we are going to close the session now, unless there's any other questions or comments from the team here. That'll do it.

Operator

Thank you. This does conclude today's teleconference. As a reminder, the dial-in number for the replay is (800) 677-6124. Please disconnect your lines at this time and have a wonderful day.

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